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1. General Insurance Concepts
2. Producer Roles and Receipt Types
3. Principles of Life Insurance
4. Underwriting
5. Term Life Insurance
6. Whole Life Insurance
7. Variable Insurance Products
8. Group Life Insurance
9. Life Insurance Provisions
10. Annuities
10.1 Annuity Basics and Accumulation
10.2 Payouts and Advanced Options
11. Taxation of Life Insurance Products
12. Qualified Retirement Plans
Wrapping up
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10.2 Payouts and Advanced Options
Achievable Life
10. Annuities
Our Insurance Life course is in "early access"; the content on this page is a work-in-progress.

Payouts and Advanced Options

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The available annuity payout options are as follows:

  • Life Income (Straight): The straight annuity payout option is the riskiest option, but has the highest monthly payment. The payments are guaranteed for life and cease at the death of the annuitant.

  • Period Certain: This payout option is more conservative than straight life and results in a lower monthly payment. Payments are guaranteed for the life of the annuitant, but only the period certain (for example, 10 or 20 years) is guaranteed. If the annuitant dies during that period, the beneficiary receives the remaining payments. If the annuitant outlives the period, payments stop at death.

  • Refund: This is the most conservative option and has the lowest payments. If the annuitant dies before receiving payments equal to the contract’s value at annuitization, the beneficiary receives the remaining balance. Refunds may be paid either in a lump sum (cash refund) or in continued installments (installment refund).

  • Joint Life: The joint life annuity payout option covers two or more people, commonly spouses. The contract will pay monthly as long as one of the annuitants is living. Depending on the contract, the payment may remain steady or may be reduced at the death of the first annuitant.

Available annuity payout options

Taxation of annuity payments differs from withdrawals during the accumulation stage. Once a contract has been annuitized, the 10% early withdrawal penalty no longer applies because payments are treated as a scheduled annuity stream, not as withdrawals. The tax liability applies only to the portion of each payment that represents growth. Fixed annuity payments stay the same each month, while variable annuity payments may change based on investment performance.

The IRS accommodates for portability of funds in life insurance and annuity contracts. Internal Revenue Code 1035 allows the transfer of funds from one product to another or from one company to another. Under 1035 exchange rules, tax on accumulated earnings will be deferred for the following transfers:

  • Life insurance policy into another Life insurance policy
  • Life insurance policy into an annuity
  • Annuity into another annuity
Sidenote
Know this...

It is not possible under rule 1035 to transfer an annuity into life insurance

Internal Revenue Code 1035 rules

Equity Indexed Annuities

Equity indexed annuities are fixed annuities that offer a guarantee against loss of principal if held to term. With an equity indexed annuity, interest credited is linked to the upward movement of a designated index, such as the Standard and Poor’s 500 (S&P 500). If the index moves upward, the interest rate is based on some portion of the increase. If the index moves downward, the equity indexed annuity does not lose value.

Market Value Adjusted Annuities

Another fixed annuity product with a market driven aspect is the market value adjusted annuity. Rather than having the interest rate linked to an index, as with an equity indexed annuity, a market value adjusted annuity’s interest rate remains fixed. The market value adjustment feature applies only if the contract is surrendered before the contract period expires.

If a market value adjusted annuity owner surrenders the contract early, a surrender charge and a market value adjustment will apply. If interest rates decrease during the contract period, the adjustment will be positive and may add to the surrender value of the contract. However, if interest rates increase over the period, the adjustment will be negative and may increase the contract’s surrender charge.

Sidenote
Know this...

Marketing material of market value adjusted annuities must plainly state that the adjustment may be positive or negative.

Lesson Summary

IRS rules under Code 1035 allow portability of funds between life insurance and annuity contracts, deferring tax on certain transfers such as life-to-life, life-to-annuity, and annuity-to-annuity. Transfers from an annuity into life insurance are not permitted.

  • Equity indexed annuities offer principal protection and interest linked to an index’s upward movement without downside risk.
  • Market value adjusted annuities have fixed interest rates but include a market value adjustment feature upon early surrender, impacting surrender values based on interest rate fluctuations.

Available annuity payout options include Life Income, Period Certain, Refund, and Joint Life, each offering varying levels of risk and benefits.

Chapter Vocabulary

Definitions
Equity Indexed Annuity
A fixed annuity that earns interest or provides benefits that are linked to an external reference or equity index, subject to a minimum guarantee.
Fixed Annuity
An annuity that guarantees a specific rate of return. In the case of a deferred annuity, a minimum rate of interest is guaranteed during the savings phase. During the payment phase, a fixed amount of income, paid on a regular schedule, is guaranteed.
Index Annuity
Equity Indexed Annuity (also called Index Annuity): A fixed annuity that earns interest tied to an external equity index, such as the S&P 500, while protecting principal if held to term. All other vocabulary terms (Fixed Annuity, Joint-Life Annuity, Market-Value Adjusted Annuity, 1035 Exchange) remain accurate and can stay as-is.
Joint-Life Annuity
Payout option that continues to pay so long as at least one (of two or more) annuitants is alive.
Market-Value Adjusted Annuity
An annuity whose accumulated value is subject to a market value adjustment on surrender. The market value adjustment may be positive or negative depending on the movement of interest rates since the inception of the contract.
1035 Exchange
A nontaxable exchange of life insurance policies or annuities, as provided under section 1035 of the Internal Revenue Code.

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